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Do Price Controls Work?

In my Exec MBA microeconomics course, one of the first things we learn is how the “market” works to find a price that correctly matches supply with demand. At this equilibrium, the amount consumers desire to buy is exactly equal to the amount producers are willing to offer to the market.

To reinforce the power of that equilibrium, we also talked about what happens when the government intervenes to thwart the market from finding an equilibrium. The first example we considered was the imposition of a “price ceiling,” a maximum upper bound on prices. Our real-world example of this type of intervention was rent control, where the government imposes rules to hold prices for housing (rents) to artificially low levels so that low income families could afford these items. (Update: the April 20, 2012 New York Times published a story that apartment rents in Manhattan reached an all time high of $3,400 per month http://goo.gl/DaVNj surpassing the previous highs set in 2007. Expect this news to bring even more pressures to increase rent controls.)

As we saw in class, such attempts to “legislate away scarcity” just simply cannot work. Now, the Times provides us with a new story along the same lines. The paper published a story on April 20, 2012 (yup, coincidentally, the same day as the Manhattan rent story) about price controls in Venezuela http://goo.gl/pnQnD. Just as in the case of rent controls in Manhattan, the Venezuelan government imposed the controls to allow those with less income to be able to get access to the same commodities that the middle and upper class people had. Of course, the result is predictable. The low prices cause suppliers to offer very little produce (remember the shape of the Supply curve) while the same low prices caused significant increases in consumer desire to purchase these goods. The result is the long lines shown in the picture. Again, you simply cannot legislate away scarcity. Something has to be the rationing device. In this case, the rationing device is mostly “value of time” spent wasted in lines. And, of course, since that value of time is not translated to any reward for producers, you see greatly diminished production, exit from the industry, and a remarkably inefficient allocation of resources.

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Larry DeBrock
Josef and Margot Lakonishok Endowed Dean, College of Business and
Professor of Business Administration and
Professor of Economics